Tax Fairness

The issue of tax fairness is a complicated one. There are many who think the wealthy are overtaxed and should receive tax breaks, and there are others who believe that the poor are taxed too heavily and deserve some tax relief. When looking at the issue of tax fairness, the first question that comes up is how to define “fairness”. Although definitions might vary, there is probably agreement that there is a “burden” to paying taxes and that there is some “pain” involved with the giving of hard earned money to the government. There are many statistics that can be used to support both sides of this debate. If we are using as a definition of fairness the concepts of “burden ” and “pain” are all statistics equal? Or do some statistics demonstrate that some segments of our society have a larger “burden” or feel more “pain” when paying taxes? Read the following story by David R. Kamerschen, Ph.D., Professor of Economics, University of Georgia. After reading the story, ask yourself the following questions: does the author present a good case for tax fairness? Can anyone make an argument that there might be a better way to describe tax fairness than the way the author has?

Understanding Taxes

Let’s put tax cuts in terms everyone can understand. Suppose that every day, ten men go out for beer and the bill for all

ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:

The first four men (the poorest) would pay nothing.

The fifth would pay $1.

The sixth would pay $3.

The seventh would pay $7.

The eighth would pay $12.

The ninth would pay $18.

The tenth man (the richest) would pay $59.

So, that’s what they decided to do.

The ten men drank in the bar every day and seemed quite happy

with the arrangement, until on day, the owner threw them a curve.

“Since you are all such good customers,” he said, “I’m going to reduce

the cost of your daily beer by $20.”Drinks for the ten now cost just

$80.

The group still wanted to pay their bill the way we pay our

taxes so the first four men were unaffected. They would still drink for

free. But what about the other six men – the paying customers? How

could they divide the $20 windfall so that everyone would get his ‘fair

share?’

They realized that $20 divided by six is $3.33. But if they

subtracted that from everybody’s share, then the fifth man and the

sixth man would each end up being paid to drink his beer. So, the bar

owner suggested that it would be fair to reduce each man’s bill by

roughly the same amount, and he proceeded to work out the amounts each

should pay.

And so:

The fifth man, like the first four, now paid nothing (100% savings).

The sixth now paid $2 instead of $3 (33%savings).

The seventh now pay $5 instead of $7 (28%savings).

The eighth now paid $9 instead of $12 (25% savings).

The ninth now paid $14 instead of $18 (22% savings).

The tenth now paid $49 instead of $59 (16% savings).

Each of the six was better off than before. And the first four

continued to drink for free. But once outside the restaurant, the men

began to compare their savings.

“I only got a dollar out of the $20,”declared the sixth man. He pointed

to the tenth man,” but he got $10!”

“Yeah, that’s right,” exclaimed the fifth man. “I only saved a

dollar, too. It’s unfair that he got ten times more than I!”

“That’s true!!” shouted the seventh man. “Why should he get $10 back

when I got only two? The wealthy get all the breaks!”

“Wait a minute,” yelled the first four men in unison. “We didn’t get

anything at all. The system exploits the poor!”

The nine men surrounded the tenth and beat him up.

The next night the tenth man didn’t show up for drinks, so the

nine sat down and had beers without him. But when it came time to pay

the bill, they discovered something important. They didn’t have enough

money between all of them for even half of the bill!

And that, journalists and college professors, boys and girls,

is how our tax system works. The people who pay the highest taxes

[rightfully] get most benefit from a tax reduction. Tax them too much, attack them for being

wealthy, and they just may not show up anymore. In fact, they might

start drinking overseas where the atmosphere is somewhat friendlier.

Are the statistics used in the story valid in supporting the concept of tax fairness? Or are there other statistics that might be a better indicator of tax fairness? Click here to see a rebuttal of the story.

It is well known in the field of economics that the rich do pay more in taxes than the poor (in total dollars). And that is where the problem lies. If you were wealthy and knew people thought you were not paying your fair share, you would need to come up with a story so that people wouldn’t come after your money. To do this, you need to be a magician. You get people to look at one hand, while not noticing the “magic” you are doing in the other. In this story, the reader’s attention is drawn to the “total” dollars spent, while never questioning the “percent of their income” devoted to buying drinks. For example, it appears that the person paying $59 is paying the most (and in terms of total dollars, he is). But when you look at the issue of tax fairness, which is what this story is really focusing on, then you need to look deeper. You have to look at how much it “hurts” each person to contribute to the drinking festivities. This is where you need to look at the “percent of their income” paid. So perhaps the sixth person in the story who paid $3 actually felt more “pain” in his contribution than the person who paid $59. How could this be so? I will use friendly numbers in my explanation. Suppose the person who donated $3 only makes $100. His contribution would then be 3% of his total income. Suppose the person who donated $59 makes $5000. His contribution would be 1.18% of his total income. One could argue that the person who paid $3 dollars felt almost three times the “pain” in paying for drinks than the person who paid $59.

Below is a story I devised in debating this topic on the internet. I believe it correctly emphasizes the “percent of income” fairness argument.

In the land a terrible flood ravaged the countryside. Dikes were breached, roads were washed out, and homes were destroyed. The governing council decided that funds should be raised for repairs. Because the people loved their land, they met at the city hall to collect the funds. Throughout the territory there were people who had various incomes. Each person gave a portion of their income for the repairs. When the funds were tallied the citizens noticed a pattern- that for every seven people in the land, one was wealthy, four were moderately prosperous, and two were poor. There were various amounts of funds donated by different individuals. The breakdown is below.

Person

Income

Donation

Wealthy Person

$1,000

$50

Middle class

$100

$10

Middle class

$100

$10

Middle class

$100

$8

Middle class

$100

$8

Poor Person

$50

$4

Poor Person

$25

$0

The citizens were happy. Many expressed their appreciation, especially to the wealthy who gave more than the others. Local papers wrote articles praising the generosity of the wealthy. Centers of Learning developed “schools of thought” that declared the justice in such a collection system.

When one of the wealthy visited a town, the local people would lavish praise and considered it an “honor” to be in the presence of such generous people.

There was even talk of erecting monuments.

As time passed it was discovered that the funds collected were not sufficient to complete the work. A call was made to raise more funds. The councils thought that the new funds should be raised under the same system as the first funds. As times were difficult throughout the land, no one relished the idea of setting aside more of their income for repairs. The wealthy in particular complained. They reminded the citizens of their past generosity. The “learned schools of thought” published scholarly papers on how unjust it would be to ask the wealthy to contribute more. The newspapers printed these declarations and even added their own, stating in a dignified way, that the original collection scheme was also unjust. They tried to point out that the wealthy had paid the most for the repairs. Not only had they paid the most, but they paid more than the middle class and the poor put together! It was noticed that for every $50 the wealthy donated, the middle class and poor only donated $40.00. Among the wealthy there were those who were more clever than the others and pointed out that for every group of seven, there was one person, the wealthy, who was burdened with paying over 62% of the total funds collected! Those at the “learned schools of thought” produced pamphlets that showed the breakdown of the funds collected by each group (top 1%, top 5%, top 50% etc.) and whallah! The evidence was declared clear. The wealthy should not be burdened by paying anymore for the repairs. In fact, in their zeal for justice, the wealthy asked for a donation “break” to arrive at a more just settlement. The governing councils were faced now faced with two problems.

Not only did they have to raise more funds for repairs, but it seemed as if they would also have to come up with money to give back to the wealthy.

With the rainy season approaching, what would the council do?

A meeting was convened at the city hall. Everyone was invited to the discussion to present possible solutions. Representatives from each group spoke. The poor said they would have a hard time paying more because they had very little income to begin with. They believed the wealthy should pay more because they had more. The wealthy again reiterated their point that they had already paid more than everyone else, and that the middle class should pay more because there is more of them than any other class. Each class was pointing at the other. It seemed no solution would be found.

Finally, a wise man asked to review the documents showing what each class of person donated. After a few moments he declared that the data was incomplete. He said that in order for there to be fairness, one more column needed to be added to the data. With a little deciphering, he scribbled one more column to the data. It was:

Person

Income

Donation

Percentage of Income

Wealthy Person

$1,000

$50

5%

Middle class

$100

$10

10%

Middle class

$100

$10

10%

Middle class

$100

$8

8%

Middle class

$100

$8

8%

Poor Person

$50

$4

8%

Poor Person

$25

$0

0%

The wise man declared that all groups had paid for the repairs in the past and that all groups should also pay for the new repairs. But he also declared that one group had shouldered less of a burden than the other six and that group should pay more the second time around. And that group was- the wealthy! Gasps were heard throughout the room. Some of the wealthy put on airs, others fainted, while still others talked of moving to a foreign land. But those with a sense of fairness in the room, recognized the justice in the wise man’s proclamations. (End of story)

Now, this is not the only issue of fairness surrounding taxes. It could also be argued that if the wealthy pay more in taxes that they should- since they get the most benefits out of government. Here is a paragraph that I grabbed off a website that does a good job of explaining why:

“Consider defense, for example, which makes up 20% of the budget. Defending the country benefits everyone; but it benefits the rich more, because they have more to defend. It’s the same principle as insurance: if you have a bigger house or a fancier car, you pay more to insure it. Social security payments, which make up another 20% of the budget, are dependent on income– if you’ve put more into the system, you get higher payments when you retire.

Investments in the nation’s infrastructure– transportation, education, research & development, energy, police subsidies, the courts, etc.– again are more useful the more you have. The interstates and airports benefit interstate commerce and people who can travel, not ghetto dwellers. Energy is used disproportionately by the rich and by industry. As for public education, the better public schools are the ones attended by the moderately well off. The very well off ship their offspring off to private schools; but it is their companies that benefit from a well-educated public. (If you don’t think that’s a benefit, go start up an engineering firm, or even a factory, in El Salvador. Or Watts.) The FDIC and the S&L bailout obviously most benefit investors and large depositors. A neat example: a smooth operator bought a failing S&L for $350 million, then received $2 billion from the government to help resurrect it. Beyond all this, the federal budget is top-heavy with corporate welfare. Counting tax breaks and expenditures, corporations and the rich snuffle up over $400 billion a year– compare that to the $1400 budget, or the $116 billion spent on programs for the poor. Where’s all that money go? There’s direct subsidies to agribusiness ($18 billion a year), to export companies, to maritime shippers, and to various industries– airlines, nuclear power companies, timber companies, mining companies, automakers, drug companies. There’s billions of dollars in military waste and fraud. And there’s untold billions in tax credits, deductions, and loopholes. Accelerated depreciation alone, for instance, is estimated to cost the Treasury $37 billion a year– billions more than the mortgage interest deduction. (Which itself benefits the people with the biggest mortgages. But we should encourage home ownership, shouldn’t we? Well, Canada has no interest deduction, but has about the same rate of home ownership.”

Finally, those who support tax breaks for the wealthy only want to talk about income taxes, and not taxes in general. Take the payroll tax for example. The payroll tax is no longer collected on income over $106,800, which means it is heavily skewed towards the poor and middle class. The wealthy only want to complain about the “unfairness” of the progressive tax, but never want to talk about the unfairness of regressive taxes. If you add in the sales tax, excise tax, and gas tax, the percentage of incomes devoted to these taxes becomes even more skewed.

Remember, when someone has an advantage, they will try to do everything they can to maintain that advantage- even hire an economics professor to devise a story that serves their interest.